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Jack’s money machine

Does the world’s largest fintech company deserve a valuation which is half that of the world’s largest bank? For that is what Ant Financial has just achieved relative to ICBC after raising $10 billion from a final fundraising round ahead of what is expected to be one of the most hotly anticipated global IPOs this century.

Ant’s revenues currently stand at one ninth of ICBC’s, or Rmb61.93 billion ($9.67 billion) at its March year-end. The gulf between Ant’s pre-tax profits and ICBC’s is even bigger. Bloomberg says Ant reported Rmb9.18 billion in the previous financial year compared to Rmb371 billion at China’s largest state-owned bank by market value.

Yet this fact does not appear to have put off a long list of the world’s most illustrious private equity investors, which have piled into a company that is now valued at $150 billion compared to ICBC’s $313 billion.

One reason is that this latest fundraising round is the first one that international investors have been able to participate in. Singapore’s Temasek is reportedly the lead investor among a group that also includes Warburg Pincus, Khazanah, Carlyle and Sequoia.

The company’s biggest shareholders include Alibaba’s management, Ant’s own senior executives and various state-owned investment funds such as the National Security Fund and China Investment Corp.

But the main reason for investors’ enthusiasm is down to Ant’s growth potential at home and abroad thanks to its disruptive impact on the traditional financial services industry. For Ant Financial is to China what the Medici family once was to the Vatican. Ant has gained a strong hold over money flows in the world’s most populous and increasingly richest state: China.

And history has repeatedly demonstrated that those who manage financial flows – from the Medicis in Renaissance Europe to the Rothschilds at the height of the industrial revolution and more recently the US investment banks in the run-up to the 2008 global financial crisis – accrue a great share of that wealth for themselves.

The past also provides two other valuable lessons. One is that today’s winners can quickly become tomorrow’s losers as Ant is threatening to demonstrate vis-a-vis China’s state-owned banks.

It took three centuries for the banking dynasty that Cosimo Medici founded to end in ignominy after the last duke died of syphilis following a life of debauchery rather than hard work. Financial empires can rise and fall far more quickly today. Mainstream banks are all too aware of just how quickly their income might be decimated by asset-light online platforms with better user experiences.

Such has been the pace of change that the rising star of China’s payments world in the noughties – bank card issuer UnionPay – has been eclipsed by mobile payment providers like Ant Financial’s Alipay and Tencent’s WeChat Pay. Last week, the National Institution of Financial Development (NIFD) reported that Alipay controlled 29.2% of China’s online payments in 2017 compared to WePay’s 18.3% and UnionPay’s 16.3%.

As HSBC writes in a recent research report, “Mobile payments [in China] have become much more popular than cash and infinitely more so than credit and debit cards.”

More importantly, HSBC adds that, “the wealth of data collected from these transactions, combined with cloud services, is helping to provide solutions such as real-time credit checks to more targeted recommendations for online purchases.”

As a result, Ant and its ilk have the potential to become far more than just internet marketplaces for financial products. The data they collect could displace banks from what they are supposed to do best: credit risk analysis.

But history’s second lesson is one which is already changing Ant Financial’s strategy, to the detriment of analysts’ financial modelling and many of the assumptions underpinning its current valuation. For if the 2008 crisis taught the world’s governments anything it was to make sure that the financial services sector does not pose systemic risk to the wider economy.

As a result, China is starting to regulate fintech providers far more actively. One particularly notable move was the decision to block Ant Financial from funding its micro-lending business through asset-backed issuance, forcing it to partner with mainstream banks instead.

Many analysts point out that its micro-lending platforms – Huabei (Just Spend) and Jiebei (Just Borrow) – are the most lucrative part of Ant’s business, contributing anywhere from 30% to 50% of profits. They are also very clear about how little capital backs this business (about 2% according to Orient Capital) compared to the double-digit ratios mainstream banks have to adhere to under Basel III, the international regulatory framework for the banking industry.

Any change to this capital regime will dent Ant’s future profits. Over the past year, the group has responded to the regulatory threat by trying to prove that it is as prudent as mainstream banks. It has limited the amount of cash investors can invest in its hugely popular money market fund Yu’e Bao, already the world’s biggest, according to Reuters. It has also prohibited consumer loans with annual interest rates above 24%.

It has even curtailed the activities of its risk management arm, Sesame Credit. Instead of issuing individual credit ratings, it has retreated back to credit checks for services like Ofo, the bike rental app.

But as Reuters reports this week, the biggest change of all may now be in the offing. It cites company documents, which show that Ant Financial sees its future helping other banks to curtail systemic risk rather than going head-to-head with them in their core lending and wealth management businesses.

Over the next few years, Ant will focus less on expanding its platform’s range of financial products and work more on exporting its technological expertise to help banks manage risk more effectively. According to Reuters, Ant believes this part of its business will account for 65% of revenues within five years, up from 34% in 2017. Online payments, meanwhile, will drop from 54% to 28% and financial services from 11% to 6%.

It gives true meaning to a phrase that founder Jack Ma coined back in 2016 when he said Ant Financial was about “techfin rather than fintech”. His point: Ant will become a company led more by technology than financial services.

But it will still be one that will grow a lot quicker than its mainstream banking peers, underscoring why Ant will remain the world’s most valuable unicorn. Between 2017 and 2021, Ant projects that revenues will grow by a compound annual growth (CAGR) rate of 40%. By contrast, analysts forecast ICBC’s revenues to increase by 7% to 8% over the same period, slightly above China’s GDP growth rate.

The company itself argues that its current valuation is reasonable. Caixin Weekly cites insiders who say the only reason its market value has appeared to grow so quickly is because Ant sold equity to state-owned funds at big discounts in previous funding rounds. As a result, its “real” valuation in 2017 was $100 billion and not the $60 billion reported at the time.

The general public doesn’t appear to be that fussed about valuation issues. Ant Financial is incredibly popular and just like its parent, Alibaba, its forthcoming IPO (rumoured to be in Hong Kong and mainland China) should be a huge success. Social media commentators describe its services as essential to their daily lives and a benefit to society. Some even think the whole regulatory equation should be turned on its head. “Far better that Ant is sent to supervise the state-owned banks,” observed one. Ant’s new tech-driven risk-management strategy evidences that Jack Ma probably couldn’t agree more.

Keeping track, Jun 8, 2018: Existing Chinese investors in Ant provided funds for a yuan-denominated tranche, the company said. Ant raised $11 billion in the US dollar portion of its fundraising and $3 billion from domestic investors, and both tranches were oversubscribed, according to people familiar with the matter. The news of the increased amount ($4 billion more than previously thought) came after the publication of this article.

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